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Why These Stocks Matter Right Now

This market doesn't have to spell disaster for retirees.

Markets like this are scary for investors at any stage of life, but they're downright terrifying for retirees. The tumult has clearly started to take effect. According to a Washington Post/ABC News poll cited in the Post:

Among those 50 to 64, more than six in 10 are not confident -- including a third who are "not at all confident" -- that they will be able to retire with enough money to carry them through the rest of their lives.

As if the volatile stock market weren't enough, interest rates on bonds and savings accounts are extremely low right now. That's bad news for retirees, who rely on withdrawals from principal and interest income to maintain their lifestyles. A declining stock market and a low-interest-rate environment means they may have to sell stocks at a loss -- thus reducing their principal or "capital base."

In their book All About Dividend Investing, Don Schreiber Jr. and Gary E. Stroik call this phenomenon "dollar lost averaging":

As the stocks go down, you have to sell more of your position and begin liquidating more of your capital base in order to meet the given income need. ... When you have bear markets ... you eviscerate so much of your capital base you may never be able to recover.

While last week's market activity is a reminder of the very real risks of stock investing, retirees (or near retirees) can ill afford to swear off stocks forever. With today's medical technology, "retirement" could last for three decades -- and with that kind of holding period, you'd need the power of stocks to give a boost to some of your lower-risk, lower-reward investments.

Locking in losses today also leaves your bonds and CDs with much less principal from which you can draw interest in the future. Consider:

Principal/Capital Base

Annual Interest at 4%

$100,000

$4,000

$80,000

$3,200

$60,000

$2,400

As you can see, when Schreiber and Stroik say you might "never be able to recover," it's not hyperbole. In retirement, you want to preserve your capital base as long as possible -- that means your focus should be on maximizing the income generated by your portfolio, to ensure that you don't need to sell down your principal to make ends meet.

What to doHere's what I'd recommend to reduce the risk of a nightmarish scenario: Round out an income-focused portfolio of bonds, CDs, and mutual funds with a diversified group of dividend-paying stocks.

More specifically, you'll want stocks with the following characteristics:

Large market capitalization

Current yield greater than 3%

A history of increasing dividends

Manageable debt loads -- meaning the company has ample money to pay the interest charges on its debt, measured by its interest coverage ratio

Sufficient dividend coverage on a free cash flow basis -- meaning the company can fund its dividend payments with free cash flow

To give you a few ideas for further research, here are six companies that meet those criteria:

Company

Current Yield

Interest Coverage Ratio

Pfizer(NYSE:PFE)

8.5%

51.4

Home Depot(NYSE:HD)

4.6%

12.1

Freeport-McMoRan(NYSE:FCX)

5.5%

16.4

Kraft(NYSE:KFT)

4.3%

5.6

Waste Management(NYSE:WMI)

4.2%

7.3

ConocoPhillips(NYSE:COP)

3.9%

32.9

Data from Capital IQ, a division of Standard & Poor's.

While an interest coverage ratio in the 30s or 50s is abnormally high, it shows that Pfizer and Conoco have "very, very manageable" debt levels. What's more, because these companies all have histories of growing dividend payments, you can expect to keep raking in periodic cash payouts while you wait out natural market fluctuations -- unlike with non-dividend-paying stocks, where you're completely reliant on the price the market is willing to pay for your shares. Having such an income lifeboat in rough markets can also save you from selling your stocks at exactly the wrong time.

Other areas of the equity market to consider for income are master limited partnerships (MLPs) like TEPPCO Partners and real estate investment trusts (REITs) like Mack-Cali Realty(NYSE:CLI). Both company structures can produce higher-than-average yields for investors (TEPPCO currently yields 14.4% and Mack-Cali 8.5%) but REITs and MLPs also present two major caveats: most are heavily reliant on debt financing and can also create unique tax arrangements for you come April 15. Before investing in companies with either structure, you should fully understand the potential tax consequences.

Getting startedIn markets like this one, it's important to keep in mind that because every proper retirement portfolio should include equities, your capital base will inevitably fluctuate from time to time -- andthat's OK. After all, we accept volatility in the stock market in exchange for the prospect of higher returns.

With the chaos in the financial markets, many dividend-paying stocks have been hit hard over the past year. But solid dividend payers still matter right now -- they'll give you a steady stream of quarterly checks, reducing the need to panic-sell, and allowing your capital base to remain untouched and grow over the long run. You won't have to worry about "dollar lost averaging" your portfolio to a point from which you may never recover.

If you'd like a little more guidance in developing a proper retirement plan, our Motley Fool Rule Your Retirement service can help. Advisor Robert Brokamp discusses everything from wealth defense to bond selection to generating income for life -- and you can try Rule Your Retirement free for 30 days. To learn more about this special trial, simply click here.

Todd Wenningfiddles when he can and works when he should. He owns shares of Pfizer and Home Depot, but of no other company mentioned.TEPPCO Partners, Pfizer, and Kraft Foods are Motley Fool Income Investor recommendations. Waste Management, Pfizer, and Home Depot are Motley Fool Inside Value recommendations. The Fool'sdisclosure policywhittled a likeness of Hank Paulson over the weekend.